Loading...
HomeMy WebLinkAboutSE Intertie KPU construction proposal 1999ALASKA INDUSTRIAL DEVELOPMENT e_ > ¢ AND EXPORT AUTHORITY f= ALASKA @@E— ENERGY AUTHORITY 480 WEST TUDOR ANCHORAGE, ALASKA 99503 907 / 269-3000 FAX 907 / 269-3044 IL. Introduction and Executive Summary The Alaska Industrial Development and Export Authority (AIDEA) was asked to perform a review of the proposal being advanced by Ketchikan Public Utilities (KPU) for funding and construction of the proposed Southeast Intertie (the “Intertie”). The review has two primary aspects. The first provides an economic analysis and comparison of the Southeast Intertie (using the KPU proposal) to other alternative projects that could serve Ketchikan’s needs. The second aspect examines the financing issues surrounding the KPU proposal. AIDEA engaged CH2M Hill to perform the economic analysis and comparison aspect of the review. CH2M Hill performed two analyses for this purpose. The Economic/ Resource Analysis compares the actual cost to build and operate the Intertie, irrespective of who pays for those costs, to costs for other alternatives such as the Mahoney Lake project, other small hydroelectric projects and additional diesel generation. The Rate Impact Analysis examines the rate impacts to the Ketchikan energy consumers of the various alternatives. CH2M Hill also performed sensitivity analyses with respect to various assumptions. These analyses include considering the impact of significantly increased diesel fuel costs. CH2M Hill's Economic/Resource Analysis indicates that, in almost all cases, the Intertie is not the best economic choice to meet Ketchikan’s future load requirements. Under certain growth conditions, however, if high diesel fuel prices are assumed, the Intertie has a resource cost comparable to the other alternatives. From a rate impact perspective, CH2M Hill’s analysis indicates that the Intertie would increase power rates in the Ketchikan area relative to the other power options available. AIDEA engaged its financial advisor, Pat Clancy of Clancy Gardiner and Pierce, to analyze the various financing issues related to KPU’s proposal. Mr. Clancy's analysis indicates that the KPU financing proposal, as currently envisioned, would not provide a sufficient structure for the issuance of revenue bonds. If several structural changes are made, however, Mr. Clancy concludes that it may be possible to structure an investment grade bond issue. Among the required changes is the need for a credit- worthy entity to guarantee bond debt service. The economic and financial analyses performed by AIDEA’s consultants do not completely resolve the question of whether the KPU proposal has merit. Instead, these analyses provide a framework for consideration of the various public policy issues surrounding the Intertie. There are a number of additional factors (both positive and negative) that must be considered from a policy perspective in making a determination if the Intertie should proceed. These include the Intertie’s integration with the Southeast Alaska Electrical Intertie System Plan, currently available federal funding opportunities for the Intertie, watershed considerations, and policy considerations related to public versus private sector funding of energy projects. If a decision is made to proceed with the Intertie, AIDEA has identified certain basic elements that would be required. These include appropriate legislation, financial guarantees, and contractual agreements. IL. Background A. Southeast Intertie The proposed Southeast Intertie would connect the Tyee Hydroelectric Project (a part of the Four Dam Pool projects) with the Ketchikan area. Unused surplus power from the Tyee project (now serving only Petersburg and Wrangell) would be transmitted via the Intertie to Ketchikan.’ Currently, Ketchikan’s primary source of power is the Swan Lake Hydroelectric Project (also a part of the Four Dam Pool) and other local hydroelectric projects. These projects do not supply sufficient power to cover all of Ketchikan’s needs and therefore KPU supplements these local hydroelectric resources with diesel generation. The following table depicts KPU’s existing generation resources: Existing KPU Generation Resources Resource 1998 Actual (MWh) Average Annual Capability (MWh) Swan Lake 71,078 80,700 Other KPU Hydro 66,251 64,600 Diesel 26,798 141,220 TOTAL 164,127 286,520 In 1998, KPU’s average retail rate for power was approximately 9.2 cents per KWh. This rate compares favorably with energy rates in Southcentral Alaska and is below statewide averages. The proposed Intertie would allow for load growth in Ketchikan and reduce the need for diesel generation. The Southeast Intertie would, for the first time, link two of the Four " As energy loads grow in Petersburg and Wrangell less surplus energy would be available for transmission to Ketchikan over the Intertie. While the Tyee Project has the capability of adding an additional turbine, because of water constraints, an additional turbine would not increase the overall energy producing capability of the Tyee project. Southeast Intertie Review April 12, 1999 Page 2 Dam Pool projects. Because operating costs for all of the Four Dam Pool projects are pooled, depending on the rate at which power was purchased, sale of power to Ketchikan from the Tyee project would somewhat lower the operating costs of the Four Dam Pool on a per kilowatt hour basis. This reduction would reduce power costs for all of the Four Dam Pool communities. Gross state revenues from the Four Dam Pool projects would also increase. In addition, the Intertie could open the possibility of future generation projects in proximity to the Intertie. The Southeast Intertie is part of the first phase of a proposed $436 million Southeast Alaska Electrical Intertie System Plan developed for the Southeast Conference. This System Plan was developed to integrate development of proposed intertie segments with new hydroelectric generation capacity for the region. To date, funding proposals for the remainder of the System Plan have not been developed. B. Alternatives In addition to the Southeast Intertie, other projects have been proposed which could serve Ketchikan’s energy needs for the foreseeable future. The Mahoney Lake project is a 10 MW hydroelectric project being promoted by Ketchikan Electric Company (KEC). KEC holds a Federal Energy Regulatory Commission license for the project. KEC is a joint venture between Alaska Power and Telephone (APT) and the Cape Fox Corporation. Other proposed hydroelectric projects that could be developed by KPU include the 5.3 MW Whitman Lake project, the 1.9 MW Lake Connell project, and the 1.2 MW Carlanna Lake project. KPU currently uses diesel generation to supplement its Swan Lake power. Subject to air permitting requirements, KPU could add new diesel facilities to increase its generation capacity.? Even if the Intertie or other hydroelectric alternatives were chosen to meet Ketchikan’s energy requirements, under certain scenarios, additional diesel backup reserve generation would nonetheless be required. The following table compares Ketchikan’s various energy resource alternatives along with their estimated cost and projected generating capability.* ? Under high energy growth conditions, increased diesel generation in Ketchikan could be limited by air emission regulatory and permitting requirements. 3 R.W. Beck’s 1998 update to KPU’s Power Planning Study indicates that approximately 10,200 MWh of hydroelectric energy and as much as 37,600 MWh of diesel energy might be available through an interconnection of Ketchikan with the Metlakatla Power & Light (MPL) system. In addition, the interconnection could also provide reserve capacity to KPU and additional hydroelectric power generation with upgrades to the MPL system. Assuming that KPU would pay for the interconnection and the upgrades, R.W. Beck found that, from a cost standpoint, the MPL interconnection was similar to KPU adding the small hydro projects to its system. CH2M Hill did not analyze the MPL interconnection alternative. Southeast Intertie Review April 12, 1999 Page 3 Ketchikan Energy Resource Alternatives 1998 Estimated Project Cost ($ millions Capacity (MW) Energy Available (MWh) Intertie $77.2 ° 20.0 ° 88,769 ° Mahoney Lake $17.5 ¢ 10.0 41,740 Whitman Lake $ 7.1 5.3 19,880 Lake Connell $ 5.4 1.9 12,200 Carlanna Lake $ 4.2 +2 6,665 New Diesel (low speed): Without power house $ 83 6.4 53,260 ° With power house $17.3 6.4 53,260 ° Notes to table: * Represents full estimated construction cost before timber sale credit. Represents Tyee capability; actual availability will vary annually based on water conditions and Wrangell and Petersburg loads. Represents average Tyee capability reduced by FY1998 Wrangell and Petersburg loads actually serviced by Tyee. Actual availability will vary annually based on water conditions and actual Petersburg and Wrangell loads. Per KEC estimate. A 1998 R.W. Beck study used a capital cost of $28.8 million for Mahoney Lake. Assumes 95% availability. Ill. Original Financing Proposal In 1993, legislation was enacted that formed the basis for the original financing proposal for the Southeast Intertie. Under the legislation, KPU was to own the Intertie for the benefit of the utilities participating. The legislation created three potential funding sources. First, $20 million was appropriated to the Department of Community and Regional Affairs to be used as a loan to the participating utilities for the Intertie. This loan was to have a term of 15 years and bear interest at 3%. Second, subject to appropriation each year, the legislation allocated 40% of the State’s Four Dam Pool revenue stream to the Southeast Energy Fund.* To date, $11.3 million in grants from * Under the Power Sales Agreement (PSA) for the Four Dam Pool, the Alaska Energy Authority (AEA) sells power from the projects to the five local utilities serving the Ketchikan, Wrangell, Petersburg, Kodiak, Glennallen, and Valdez areas. Power from the projects is sold to the utilities at a rate determined under the PSA. The rate has two components. The power cost production component covers the actual operation and maintenance costs for the projects. This component also includes a fixed $500,000 per year contribution to a project renewal and replacement fund to be used for renewals and replacements of project facilities and equipment. The debt service component provides for payments to the State based upon a schedule contained in the agreement. Under the PSA, the State is responsible for certain significant project liabilities. These include uninsured facility failures, substandard performance and deficiencies in the renewal and replacement fund. The PSA provides that the utilities may withhold the debt service component payments to the State if AEA is unable to otherwise obtain funds to meet its obligations under the PSA. This right is generally referred to as the utilities’ self-help right. In FY 1999, the uniform Four Dam Pool rate is 6.8 cents per kWh. As part of legislation passed in 1993 that reorganized the AEA (see footnote 5), subject to annual appropriation, the Legislature pre-allocated the debt service component payments received by the State as follows: 40% to the Power Cost Equalization and Rural Electric Capitalization Fund, 40% to the Southeast Energy Fund, and 20% to Southeast Intertie Review April 12, 1999 Page 4 the Southeast Energy Fund have been made or committed to KPU for Southeast Intertie related activities. Finally, the legislation authorized AIDEA to issue up to $40 million in revenue bonds to finance the Intertie.° In addition to the funding sources for the Intertie identified in the 1993 legislation, KPU has actively sought federal funding for the Intertie. To date, $9,900,000 in federal grants has been made available for the Intertie and additional federal funds have been requested. Based upon the various funding sources identified, KPU developed its original financing proposal. Recognizing that the cost of power from the Intertie would be unacceptable if KPU were required to pay the uniform Four Dam Pool rate for power, pay the operating costs for the Intertie and also make the debt service payments contemplated in the 1993 legislation, KPU proposed that it pay a reduced rate for the Tyee power. KPU proposed that the rate for Tyee power be at a level that when added to its other Intertie related costs (debt service, operation, maintenance, etc.), resulted in a total cost of power in Ketchikan equal to the uniform Four Dam Pool rate of 6.8 cents per kilowatt hour. Put another way, KPU proposed reducing the uniform Four Dam Pool rate by an amount sufficient to cover its entire Intertie related costs. KPU’s analysis indicated that, initially, no payments could be made for the Tyee power. Moreover, to ensure no increase to the Ketchikan ratepayers in the early years of operation, KPU indicated it might require access to a working capital loan. KPU proposed that it obtain such a loan from AIDEA for this purpose. After significant analysis and discussions with its financial advisor, KPU determined that it would not be prudent for the Ketchikan community to incur the level of debt required by the original financing plan. The KPU debt contemplated in the original proposal would have severely impacted Ketchikan’s future borrowing ability. Accordingly, KPU abandoned the original financing proposal. the Power Project Fund. No portion of the debt service payment was allocated to AEA to fulfill any of its obligations under the PSA. ° The 1993 legislation was part of an overall reorganization of AEA. Previously, AEA’s primary mission was to construct, own and operate energy infrastructure projects for the benefit of local utilities and consumers. The 1993 legislation signaled a change in policy with respect to State ownership of energy projects. The legislation eliminated AEA’s ability to acquire and construct new projects. Wherever possible, AEA was to contract with local utilities for the operation of the existing facilities. These policy changes are reflected in the legislative treatment of the Southeast Intertie. Despite the fact that the Southeast Intertie was to link two AEA owned Four Dam Pool facilities, the legislation called for KPU ownership of the Intertie. Moreover, the Intertie was to be financed by loans and bonds to be repaid directly from payments made by KPU and the other participating utilities. Southeast Intertie Review April 12, 1999 Page 5 IV. Current KPU Proposal In the fall of 1998, KPU formulated a new financing plan for the Southeast Intertie. Under the KPU proposal the State would own the Intertie.® The State, presumably through AEA, would issue revenue bonds in an amount sufficient to provide proceeds to fund the remaining costs of the Intertie. Debt service for these bonds would be paid from the 40% share of the State’s Four Dam Pool revenues currently allocated to the Southeast Energy Fund. Under KPU’s proposal, the $20,000,000 DCRA loan contemplated in the 1993 legislation would not be utilized and could be immediately released for other purposes. KPU would enter into an interruptible power sales agreement for power received over the Intertie from the Tyee facility. While KPU has indicated that an acceptable interruptible power sales agreement will need to be negotiated, KPU has assumed that Tyee power would be sold to KPU at or near the current Four Dam Pool rate. The following table depicts the current KPU funding proposal. Funding Available: State Grants Authorized/Received $11,200,000’ Fed. Grants Authorized/Received 9,900,000 Timber Sale Credit 4,000,000 25,100,000 Additional Funding Proposed: Additional Proposed Federal Grants 7,500,000° Proposed State Bond Proceeds 44.600,000° 52,100,000 Total Estimated Intertie Cost (As of 9/98 in 1997 dollars) $77,200,000 V. Economic Analysis AIDEA engaged CH2M Hill to perform an economic analysis for the Southeast Intertie. CH2M Hill’s report is attached as Exhibit “1” to this memorandum. CH2M Hill evaluated both the economics and rate impacts of the Intertie and the various power resource alternatives. The CH2M Hill report describes in detail the assumptions utilized and the ° As the Southeast Intertie would connect two AEA owned Four Dam Pool projects, AEA is the logical choice for State ownership. 7 The Department of Community and Regional Affairs, Division of Energy, recently notified KPU that an additional $4.4 million in State grant funds are available for the Intertie from the Southeast Energy Fund. Disbursement of these funds is contingent, however, on a number of conditions including development and approval of a financing plan for the Intertie and the execution of appropriate agreements. Because KPU’s proposal did not include these additional State grant funds, these funds have not been included in this analysis. Obviously, any additional State grant funds actually received would reduce the remaining funding required. * KPU is seeking more than the $7,500,000 in additional federal grants for the project. Any increase in federal grants would reduce the amount of State bond proceeds required. We understand that the Clinton Administration recently introduced energy legislation that includes authorization language to provide up to $20,000,000 for the Intertie. To date, however, no federal appropriation for the Intertie has been introduced. Southeast Intertie Review April 12, 1999 Page 6 conclusions reached. CH2M Hill’s assumptions were shared with KPU. CH2M Hill considered KPU’s comments and modified certain assumptions. In addition, CH2M Hill performed sensitivity analyses with respect to various assumptions. The following sections briefly describe key elements of the report. A. Load Forecasts In performing its analysis, CH2M Hill was not tasked with developing new energy load forecasts for the Ketchikan area. Rather, CH2M Hill utilized the June 1998 load forecasts prepared for KPU by the Institute of Social and Economic Research (ISER). ISER had developed three load forecasts utilizing high, medium, and low growth assumptions for the Ketchikan area. CH2M Hill examined these forecasts and made adjustments based upon discussions with KPU staff. The result of these adjustments was to increase the ISER forecast loads in the medium and high growth scenarios. These adjusted load forecasts were then used by CH2M Hill in performing its analysis. B. Alternatives Reviewed Based on available information, in performing its economic analysis, CH2M Hill examined the following alternative cases: All Diesel —- This case assumes that no other alternative is chosen and therefore Ketchikan’s future energy demands are satisfied entirely by adding additional diesel generation. This case assumes fuel costs of 63 cents per gallon in 1998 and 58 cents per gallon in 1999 then escalating to 66 cents per gallon in 2018. CH2M Hill also performed a sensitivity analysis assuming fuel prices of 85 cents per gallon. Southeast Intertie - This case assumes construction of the Southeast Intertie. The option also assumes additional replacement (reserve) diesel generation will be required in the future. The timing of the diesel reserve requirement is dependent on the particular load forecast utilized. Mahoney Lake — This case assumes development of the Mahoney Lake project based upon proposals advanced by KEC. Depending on the load forecast utilized, replacement diesel reserve generation is also included. The high load forecast case assumes that the small hydro plants are developed instead of the addition of new diesel units. Mahoney Lake & Intertie —- In the medium and high load growth scenarios, this case assumes that both the Mahoney Lake and Southeast Intertie projects are constructed. In the medium growth scenario the Mahoney Lake project is constructed first followed by the Intertie. In the high growth scenario both projects are constructed at the same time. Southeast Intertie Review April 12, 1999 Page 7 Small Hydro — This case assumes development of the Whitman Lake hydroelectric project and, depending on the load forecast, subsequent development of the Lake Connell hydroelectric project.? Replacement diesel reserve units are included in the high load forecast case. Cc. Economic/Resource Analysis 1. Purpose and Assumptions CH2M Hill’s Economic/Resource Analysis compares the present value of the alternative energy projects based upon the various load forecasts. This analysis ignores the funding sources for the various projects and instead compares the total capital and operational costs of the projects over a 50-year period. This methodology had been used by AEA and continues to be used by the Division of Energy in examining proposed energy projects. The methodology is designed to examine the total societal cost of choosing one energy resource over another. The Economic Resource analysis requires consideration of the capital costs of the projects being compared. Because existing funds have already been devoted to the Intertie and a substantial amount of additional federal funding is proposed, CH2M Hill developed three cases for examination of the Southeast Intertie that modify the methodology that is normally used in this type of analysis: Incremental State Cost — This case utilizes as capital costs only those additional costs required to complete the project which are to be funded with State dollars. The analysis excludes both the funds expended to date (the “sunk costs”) and future costs to be funded with federal grant dollars. Accordingly, under this case the capital cost of the Intertie is reduced by the $17.4 million dollars in federal grant funds proposed by KPU and $8.1 in funds already expended for Intertie development. Incremental Cost — This case utilizes as capital costs only those additional costs required to complete the project. It excludes all sunk costs but does not make any adjustments for proposed federal funding. This case is the most helpful for comparing the Intertie versus the other alternatives without federal grant assumptions affecting the result. Full Cost — This case utilizes the full capital cost of the Intertie including all costs expended to date (the sunk costs) and all additional costs required to complete the project. ° KPU’s analysis indicates that the Carlanna Lake project could be substituted for the Lake Connell project. CH2M Hill utilized the Lake Connell project in its analysis because a preliminary FERC license has been obtained for that project and that project is capable of displacing more high-cost diesel generation thereby reducing overall costs. Southeast Intertie Review April 12, 1999 Page 8 Two separate construction cost estimates were utilized in examining the Mahoney Lake project. KEC estimates the cost of Mahoney at approximately $17.5 million. A 1998 R.W. Beck study prepared for KPU used a capital cost of $28.8 million for the Mahoney Lake project. CH2M developed two Mahoney cases, a high and low capital case, utilizing the differing construction cost estimates 23 Findings CH2M Hill draws several conclusions from the Economic Resource analysis. Among the most significant are: In a medium growth scenario, the low capital cost Mahoney case is the least costly, closely followed by the Small Hydro alternative. If the high capital cost Mahoney case is considered, under a medium growth scenario, the Small Hydro alternative is the least costly followed by Mahoney Lake. Even when considered at the incremental state costs (excluding all federal grants and sunk costs), under a medium growth scenario, the Intertie is significantly more costly than the Mahoney Lake or Small Hydro alternatives. In a high growth scenario, the low capital cost Mahoney Lake project augmented by development of Small Hydro is the least costly alternative closely followed by the Mahoney Lake & Intertie alternative. In a low growth scenario, the Small Hydro alternative is the least costly by a substantial margin followed by the All Diesel alternative. Under medium growth conditions, if higher diesel prices are assumed, the Intertie (considered at incremental state (lowest) cost), Mahoney Lake, and Mahoney Lake augmented by future Intertie development all have comparable costs. Under high growth conditions, if higher diesel prices are assumed, Mahoney Lake augmented with future Intertie development is the least costly alternative followed by the Intertie (considered at incremental state (lowest) cost) and Mahoney Lake/Small Hydro alternatives. The CH2M Hill Economic Resource analysis demonstrates that, under most growth scenarios, the Intertie is substantially more costly than the other alternatives. Southeast Intertie Review April 12, 1999 Page 9 D. Rate Impact Analysis 1. Purpose and Assumptions CH2M Hill performed a Rate Impact Analysis. The purpose of this analysis is to compare the actual power rate impact to the Ketchikan consumer of the Intertie and the other alternative power resources. The analysis uses as a base case the All Diesel alternative and compares the rate implications of undertaking each of the other alternatives. The assumptions utilized in the analysis are described in the CH2M Hill report. The following highlights a few of the more significant assumptions: All Diesel — As KPU would be the owner of the facilities, this case utilizes the projected capital financing and operation costs for the diesel facilities. This case assumes fuel costs of 63 cents per gallon in 1998 and 58 cents per gallon in 1999 then escalating to 66 cents per gallon in 2018. Southeast Intertie - This case assumes that KPU purchases power generated from the Tyee project at 6.8 cents per kWh, the current uniform Four Dam Pool rate plus a component for renewals and replacements. This is the same assumption provided by KPU in the information forwarded to AIDEA.'° Any changes in the actual rate would require that the Rate Impact Analysis be adjusted to reflect that rate. Mahoney Lake — This case assumes that KPU would purchase power generated from the Mahoney Lake project at 6.5 cents per kWh and that the power would be subordinate to KPU’s Swan Lake power. KEC has indicated its willingness to enter into a long-term power sales agreement for Mahoney power at this rate. KEC has indicated that this rate could be lowered if federal grant funding were made available for the Mahoney Lake project. Because no grant funds have been identified the analysis does not consider this possibility. Additionally, KEC has stated it will not pursue State grant funding for the project. Small Hydro — This case utilizes the project capital financing and operation costs for the Whitman Lake and Lake Connell projects assuming KPU ownership and tax exempt financing. © This assumption is also consistent with the notion that if the State is to provide a significant portion of the capital for the Intertie (through Southeast Energy Fund grants and use of State revenues to pay debt service) the State should reasonably require that KPU pay the full Four Dam Pool rate for Tyee power. Even at this rate, CH2M Hill’s analysis indicates that the additional State revenues generated by the sale of Tyee power over the Intertie are not sufficient to pay the cost of the Intertie. Because utilization of the full Four Dam Pool rate would minimize the State subsidy for the project we believe the assumption is reasonable. Southeast Intertie Review April 12, 1999 Page 10 2 Findings Among the most significant findings from the CH2M Hill Rate Impact Analysis are: e In all but the high growth scenario, the Southeast Intertie would increase KPU rates relative to the other alternatives examined including All Diesel. e In the high growth scenario, the Southeast Intertie would result in lower rates to the KPU ratepayers than the All Diesel case, but higher rates than for the other alternatives. e In all but the high growth scenario, the Small Hydro alternative would result in the lowest cost to KPU ratepayers. e In ahigh growth scenario, Mahoney Lake augmented by Small Hydro would result in the lowest ratepayer cost. Vi.‘ Financing Issues KPU has proposed that the State issue bonds to finance the remaining costs of the Intertie. KPU has indicated that it expects to receive an additional $7,500,000 in federal funding for the Intertie. If KPU were successful in obtaining these funds, under KPU’s proposal, bond proceeds of $44,600,000 would be required to fund the project."! KPU has proposed that the debt service on these bonds be paid from the 40% share of the State’s Four Dam Pool revenues currently allocated to the Southeast Energy Fund. AIDEA asked its financial advisor, Pat Clancy of Clancy Gardiner and Pierce to review KPU’s financing proposal and analyze the various bond-financing issues. A copy of Mr. Clancy's report is attached as Exhibit “2.” In order to obtain $44.6 million in bond proceeds, Mr. Clancy estimates that approximately $51.3 million in bonds would need to be issued. This amount includes estimated issuance costs and the amount necessary to fund a debt service reserve fund. Mr. Clancy estimates the net annual debt service on the bonds would be approximately $4.13 million after taking into account earnings on the debt service reserve fund. This amount assumes a level 25-year amortization of the bonds at a taxable rate of approximately 7%." " KPU has indicated that it may actually be able to obtain federal funds substantially in excess of the projected $7,500,000. Any additional federal grant amounts received would reduce the amount of bond proceeds that would be required. '? Tt appears that under Internal Revenue Code rules, the Intertie would serve more than two contiguous “counties” and would therefore not qualify for tax exempt financing. Southeast Intertie Review April 12, 1999 Page 11 In order to issue bonds, Mr. Clancy has indicated that a stable revenue stream earmarked for payment of the debt service must be identified. The Four Dam Pool revenue stream is currently subject to annual appropriation and accordingly, as currently structured, would not provide an earmarked source of payment sufficient to issue the bonds. Presumably, this problem could be remedied with appropriate statutory changes. More importantly, however, Mr. Clancy has indicated that the Four Dam Pool revenue stream is not sufficiently stable under the Power Sales Agreement (PSA) for the projects. Under the terms of the PSA, the revenues received by the State vary with production. Because the contract is not “take or pay,” a reduction or interruption in energy generation and sales from the Four Dam Pool projects reduces payments to the State. In addition, the purchasing utilities’ “self-help” right can interrupt the State’s revenue stream if funds are needed to fulfill State obligations under the PSA. Self-help has been utilized on several occasions over the last few years to cover major repairs to the projects. Mr. Clancy also notes that 40% of the State’s revenue stream in the fiscal year 1999 would have been only $4.32 million, an amount marginally sufficient to cover estimated net debt service for the bonds of $4.13 million. Investment grade bonds typically require revenues significantly in excess of the required debt service requirement. While future growth projections indicate that the 40% revenue stream will likely grow, Mr. Clancy believes it is unlikely that 40% of Four Dam Pool revenue stream would be sufficient to provide the level of coverage necessary to support investment grade bonds. Mr. Clancy has identified a number of structural changes that could be made to address the issues identified. First, Mr. Clancy suggests that the entire debt service payment from the Four Dam Pool could first be pledged to the bond debt service. Any amounts not needed for debt service would then flow to the other allocated uses. This would provide sufficient coverage and alleviate concerns related to annual revenue changes from energy generation changes. This approach, however, would make the Intertie debt service the first priority and could limit the amount of funds available for the State to allocate for other uses such as power cost equalization. In order to eliminate the possibility that exercise of self-help could interrupt bond payments, Mr. Clancy suggests that the PSA could be amended to limit the utilities exercise of self-help. Even if such an amendment were possible, limitation of self-help might pose other problems. In recent years, self-help funds have been the only source of funds available to make major repairs to the Four Dam Pool projects. Restrictions on the availability of self-help funds could impede AEA’s ability to fulfill its obligations, potentially jeopardizing the reliability of the projects and the State’s Four Dam Pool revenues. More importantly, limitation of self-help in order to provide sufficient funds to make bond payments merely postpones self-help and ultimately reduces the State revenues available to allocate for other uses. Southeast Intertie Review April 12, 1999 Page 12 Mr. Clancy has suggested another approach that does not require modifications to the Four Dam Pool PSA or pledging of the entire State Four Dam Pool revenue stream. Mr. Clancy suggests that the 40% revenue stream could be backed by a guarantee by some sufficiently credit-worthy entity or entities. It is unclear if KPU or the other Four Dam Pool utilities have the willingness or financial strength to provide such a guarantee. Finally, Mr. Clancy notes that, under whatever structure is utilized, a plan would need to be developed that ensures the bondholders that sufficient funds from some source are available to pay the projected operation, maintenance, repair and replacement costs of the Intertie. In summary, Mf. Clancy's analysis indicates that the KPU financing proposal, as currently envisioned, would not provide a sufficient structure for the issuance of revenue bonds. The following structural changes would be required to allow financing utilizing the 40% Four Dam Pool revenue stream: e Statutory changes necessary to pledge 40% of the State Four Dam Pool revenue stream toward debt service for the bonds. e Debt service guaranteed by a sufficiently creditworthy entity or entities. e Development of an acceptable funding plan for operation, maintenance, repair and replacement costs for the Intertie. Vil. Additional Factors The economic and financial analyses discussed above do not completely resolve the question of whether the KPU proposal has merit. Instead, these analyses provide a framework for consideration of the various public policy issues surrounding the Intertie. This section will highlight some additional factors that should be considered in making a determination whether or not to proceed. A. Factors favoring the Intertie The following are some factors favoring the Intertie that should be considered. e Assuming there is support for the Southeast Alaska Electrical Intertie System Plan, the Southeast Intertie is a part of the first phase of this comprehensive plan, which could ultimately provide benefits to a large portion of Southeast Alaska. However, the other major segments are distant prospects with respect to economic and financial feasibility at the present time. Southeast Intertie Review April 12, 1999 Page 13 e The leadership positions of our congressional delegation provide an opportunity to receive federal funding for the Intertie now. It is unlikely that such an opportunity will arise again. Moreover, it is not clear that federal funding will be available for any of the other alternatives considered. e Tyee Lake and Swan Lake are supplied by independent watersheds. Therefore, the Intertie allows for optimization of water resources. On the other hand, Mahoney Lake and Swan Lake are in close proximity and utilize the same watershed. Therefore, under critical water conditions, the Intertie could provide greater flexibility. e For an additional capital cost, Tyee Lake has the capacity to create additional peak generation by adding another turbine. Because of water constraints, however, the total annual generating capability of the Tyee project would not increase. e The Intertie opens up the possibility of development of other generation sources in proximity to the Intertie route. e Under certain circumstances the Intertie could provide additional reliability and reserve potential in Petersburg and Wrangell by permitting the transfer of Swan Lake or other power generated in the Ketchikan area to be transmitted to those areas. B. Factors opposing the Intertie The following are some factors opposing the Intertie that should be considered. e The KPU proposal requires significant State investment (40% of State Four Dam Pool revenues for 25 years) to support a region that already has some of the lowest power rates in the State. e The Mahoney Lake project, a private sector project, requires no State funding or bonds yet results in lower energy rates than the Intertie under most scenarios. e The funding and federal license are: already in place for the Mahoney Lake project. Following execution of a power sales agreement with KPU, KEC estimates Mahoney could be operational in 14 months. The Intertie requires additional federal funds, enactment of State legislation and the issuance of revenue bonds. In addition, the Intertie requires two constructions seasons to complete. Given these requirements, it will likely be several years before the Intertie could be operational. Southeast Intertie Review April 12, 1999 Page 14 e The State retains substantial risks related to the Four Dam Pool. Moreover, the purchasing utilities have recently asserted that the State is responsible for certain outage and other indirect costs. In this environment, additional State ownership and financing for the Intertie may be unwise. e Divestiture of the Four Dam Pool projects has been pursued for the last few years. Issuance of revenue bonds tied to the Four Dam Pool Revenue stream creates complications that would make divestiture much more difficult. Vill. Conclusion The Economic Resource Analysis performed by CH2M Hill indicates that, in almost all cases, the Intertie is not the best economic choice to meet Ketchikan’s future load requirements. Under certain growth conditions, however, if high diesel prices are assumed, the Intertie has a cost comparable to other alternatives. CH2M Hill's rate impact analysis indicates that the Intertie would increase power rates in the Ketchikan area relative to the other power options available. As noted above, however, there are a number of other factors that could be considered in addition to a strict economic analysis. If a decision were made to proceed with the Intertie, we believe the following basic elements would be required: e Legislation authorizing the project, AEA ownership and the issuance of AEA revenue bonds to finance the remaining construction costs and devoting 40% of the Four Dam Pool revenue stream to the payment of debt service for the bonds. e Cost overruns and debt service on the bonds would need to be guaranteed by some credit worthy entity or entities, presumably KPU and/or the other Four Dam Pool purchasing utilities. e Appropriate contractual arrangements would be required to ensure that the State has no financial responsibility for operation and maintenance, reserve and replacement, or other costs related to the Intertie. Additionally, we would recommend that appropriate contractual arrangements be in place to assure that KPU purchases all of its excess power needs from the Tyee project so long as power is available from the project. This will ensure the State obtains the maximum possible recovery of its Intertie investment. Southeast Intertie Review April 12, 1999 Page 15 CH2M HILL 301 West Northern Lights Boulevard Suite 601 @ EXHIBIT 1 Anchorage, AK CH2Mi H i LL 99503-2648 a Tel 907.278.2551 Fax 907.277.9736 April 16, 1999 Mr. Dennis McCrohan Alaska Industrial Development and Export Authority 480 West Tudor Anchorage, Alaska 99503 Dear Dennis: At your request, we have evaluated the economics and potential rate impacts of power resource options for Ketchikan, Alaska. The study has particular focus on the Swan Lake- Tyee Intertie (the “Intertie”). Our analysis was conducted using KPU’s power supply planning model, developed by R.W. Beck and used in KPU’s Power Supply Planning Study (1996) and the 1998 Update. Our findings are summarized in the four attachments to this letter. Attachment A, Economic/Resource Analysis, provides economic analysis of the resource options; Attachment B, Rate Impact Analysis, provides projected rate impacts of the same options; Attachment C, Sensitivity Analysis, provides results from changes in key assumptions and projections; and Attachment D summarizes the sources of information used in the analysis. In performing this analysis, we relied on information and projections from various sources (see Attachment D) and did not conduct new, independent research as the basis for our assumptions and input data. Major findings of our study are as follow (tables supporting each finding are identified in brackets): 1. For the base-case analysis (medium load forecast) the lowest resource costs are for either Mahoney Lake or Small Hydro (Whitman and Connell Lakes) development. Even with $17.4 million in Federal funding, the Intertie is $27.3 to $28.8 million more expensive than the Small Hydro and Mahoney alternatives, respectively. [Table A-1] 2. Under high load forecast conditions, Mahoney Lake augmented with small hydro when needed, is the least-cost option. However, under these forecast conditions, construction of Mahoney Lake in conjunction with the Intertie, is almost as inexpensive. [Table A-1] 3. The Mahoney Lake and Small Hydro alternatives present much less economic risk than does the Intertie. [Table A-1] Mr. Dennis McCrohan April 16, 1999 Page 2 4. The Intertie would increase Ketchikan Public Utilities’ rates relative to the All-Diesel alternative except under high load forecast conditions. Compared with other power supply alternatives, the Intertie would increase rates under all load forecast conditions evaluated. Under medium load forecast conditions, KPU rates with the Intertie would exceed those for Small Hydro and Mahoney Lake alternatives by 0.9 to 1.2 cents per kWh, respectively. [Table B-1] 5. Under all load forecast evaluations, net revenues to the State of Alaska from Tyee Lake sales over the Intertie would be negative. This is because the state would not make enough revenues from these sales to fully offset its annual debt service on the Intertie of $4.13 million. [Table C-3] Please call me if you have any questions about these findings or the attached materials. Sincerely, CH2M HILL ne DK ane oe David A. Gray Director of Energy Economics ANC/LKB544.doc/ 991060004 Attachment A Economic/Resource Analysis of Power Supply Resource Alternatives at Ketchikan, Alaska’ 1. Under medium load forecast conditions: The least cost alternative is Mahoney Lake, if it can be built for $17.5 million. The cost of the Small Hydro (Whitman and Connell Lakes) alternative is nearly as low. Even with $17.4 million in Federal funding, the Intertie is $28.8 million more expensive than the Mahoney Lake estimate and $27.3 million more expensive than the Small Hydro alternative. Even if it were to take $28.8 million to build Mahoney Lake, the Intertie would be $18.2 million more expensive. The cost of the building Mahoney Lake and then the Intertie, when new generation is needed in 2011, is estimated to be $18.4 million higher than not adding new generation after Mahoney is complete. The Intertie with Federal funding is $15.6 million less expensive than the All Diesel alternative. One reason that the Mahoney Lake and Small Hydro alternatives are less expensive than the Intertie is that they do not require new diesel plants for reserve capacity. This is because they are not dependent upon the transmission line between Swan Lake and Ketchikan. The Intertie connects to this line at Swan Lake and as a result requires new diesel plants for reserve capacity. 2. Under the high load forecast, Mahoney Lake, augmented by small hydro when new resources are needed, is the least cost alternative. However, construction of Mahoney Lake followed by the Intertie is almost as inexpensive under this forecast. 3. Under the low load forecast, Small Hydro is the least cost alternative by a substantial margin. 4. Small Hydro provides staging opportunities that substantially reduce risk associated with uncertain future loads. 5. These conclusions are based on economic analysis of the resource costs associated with new generation for service to Ketchikan. They are supported by Table A-1 and Figures A-1 and A-2. These documents show the present value of new resources required” for each power supply alternative. ' This economic/resource analysis is based on the cost of resources for 2001 through 2027. ? Exceptions to this are shown for the Swan Lake transmission line. The new resource cost is the option entitled “Intertie (incremental)”. The Intertie (full cost) option includes costs that are already sunk in the project ($8.1 million). It therefore overstates new resource costs associated with the Intertie. The Intertie (incremental state cost) option is reduced by the amount of grant funds from the Federal government. As such, it considers resource costs only from the perspective of the State of Alaska. A-1 6. The medium, high, and low load forecasts that underlie this analysis are shown in Figure A-3 as the “Revised” forecasts. Also shown in this figure are load forecasts prepared by the Institute of Social and Economic Research (ISER) in 1998. The ISER forecasts serve as the foundation for the Revised forecasts. 7. Assumptions for this analysis are documented for the medium, high, and low load forecast cases in the pages that follow Table A-1 and Figures A-1 through A-3. High and low load forecast assumptions that vary from the medium forecast case assumptions are printed in bold. A-2 Assumptions (Medium Load Forecast) Load Forecast Based on ISER base (medium) load forecast for KPU (1998). Adjusted to include KPC sawmill load and marine layups (2 per year); adjustment adds 2.8 MW and 17,050 MWh/year. Resource Alternatives All Diesel: Assumes fuel cost of $.63/gal in 1998, $.58/gal in 1999, then increasing to $.66/gal in 2018. Replacement diesel (reserve) unit required in 2005; includes new powerhouse ($9 million in $1998). Intertie (full cost, including sunk costs): $73.2 million capital cost (total cost of $77.2 million less assumed revenue from timber sales of $4.0 million). Replacement diesel (reserve) unit required in 2005; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. Intertie (incremental cost): $73.2 million capital cost less $8.1 million expended (versus $11.2 million that has been appropriated) = $65.1 million. Replacement diesel (reserve) unit required in 2005; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. Intertie (incremental state cost): $65.1 million capital cost less $17.4 million federal grants = $47.7 million. Replacement diesel (reserve) unit required in 2005; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. A-3 ASSUMPTIONS - Medium Load Forecast (continued): Mahoney Lake: © $28.8 million (per 1998 Beck analysis) and $17.5 million (per KEC/HDR). e Capacity credit since connection is at Beaver Falls; no new diesel required. Mahoney Lake and Intertie: e Assumes Mahoney Lake constructed in 2001 and Intertie constructed in 2011. e Assumes $17.5 million capital cost. Small Hydro: e Assumes Whitman Lake (added in 2002) and Lake Connell (added in 2012). [Analysis indicates that Carlanna Lake could be substituted for Lake Connell; however, Lake Connell was used because a preliminary FERC license has been obtained for this project. Also, Lake Connell is capable of producing more energy than Carlanna Lake, which results in the displacement of more high-cost diesel generation, thereby reducing the overall cost of this scenario.] e Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. e No new diesel required. Real Discount Rate: 3.0 percent Rate Impact Analysis e Capital financed at 5.5% over 30 years. e Mahoney Lake energy at proposed KEC rate of 6.5 cents/kWh; project would be subordinate to Swan Lake. e Existing KPU hydro and non-power supply costs escalate with inflation (3% per year). A-4 Assumptions (High Load Forecast) Load Forecast Based on ISER high load forecast for KPU (1998). Adjusted to include KPC sawmill and veneer plant loads plus marine layups (4 per year); adjustment adds 5.4 MW and 47,360 MWh/year. Resource Alternatives All Diesel: Assumes fuel cost of $.63/gal in 1998, $.58/gal in 1999, then increasing to $.66/gal in 2018. Replacement diesel (reserve) units required in 2002, 2006, and 2015; includes new powerhouse ($9 million in $1998). Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2002. Intertie (full cost, including sunk costs): $73.2 million capital cost (total cost of $77.2 million less assumed revenue from timber sales of $4.0 million). Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2017. Replacement diesel (reserve) units required in 2002, 2006, and 2015; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Intertie (incremental cost): $73.2 million capital cost less $8.1 million expended (versus $11.2 million that has been appropriated) = $65.1 million. Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. A-5 ASSUMPTIONS - High Load Forecast (continued): Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2017. Replacement diesel (reserve) units required in 2002, 2006, and 2015; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Intertie (incremental state cost): $65.1 million capital cost less $17.4 million federal grants = $47.7 million. Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. Zero incremental cost of Tyee output. Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. Replacement diesel (reserve) units required in 2002, 2006, and 2015; includes new powerhouse ($9 million in $1998) to meet reserve requirements for the Swan Lake transmission line. Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2017. Mahoney Lake: $28.8 million (per 1998 Beck analysis) and $17.5 million (per KEC/HDR). Capacity credit since connection is at Beaver Falls. Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. Assumes small hydro (Whitman Lake, added in 2005, and Lake Connell, added in 2006), which results in a lower total cost than if diesel units were added. Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2016. Mahoney Lake and Intertie: Assumes both Mahoney Lake and Intertie constructed in 2001. Assumes $17.5 million capital cost. A-6 ASSUMPTIONS - High Load Forecast (continued): Small Hydro: Assumes Whitman Lake (added in 2002) and Lake Connell (added in 2005). [Analysis indicates that Carlanna Lake could be substituted for Lake Connell; however, Lake Connell was used because a preliminary FERC license has been obtained for this project. Also, Lake Connell is capable of producing more energy than Carlanna Lake, which results in the displacement of more high-cost diesel generation, thereby reducing the overall cost of this scenario.] Scenario involves continued reliance on diesel generation for a significant portion of KPU energy needs. Replacement diesel (reserve) unit required in 2011; includes new power plant ($9 million in $1998). Diesel generation air emission regulatory and permitting requirements would increase the costs of this alternative beyond the level shown. Additional costs associated with increasing permitted operations would include professional services, capital improvements, and emissions monitoring. Diesel generation exceeds permitted levels in 2008. Real Discount Rate: 3.0 percent Rate Impact Analysis Capital financed at 5.5% over 30 years. Mahoney Lake energy at proposed KEC rate of 6.5 cents/kWh; project would be subordinate to Swan Lake. Existing KPU hydro and non-power supply costs escalate with inflation (3% per year). A-7 Assumptions (Low Load Forecast) Load Forecast e Based on ISER low load forecast for KPU (1998); no adjustments. Resource Alternatives All Diesel: e Assumes fuel cost of $.63/gal in 1998, $.58/gal in 1999, then increasing to $.66/gal in 2018. e No replacement diesel (reserve) units required. Intertie (full cost, including sunk costs): ¢ $73.2 million capital cost (total cost of $77.2 million less assumed revenue from timber sales of $4.0 million). e Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. e Zero incremental cost of Tyee output. e No replacement diesel (reserve) units required. Intertie (incremental cost): ¢ $73.2 million capital cost less $8.1 million expended (versus $11.2 million that has been appropriated) = $65.1 million. e Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. e Zero incremental cost of Tyee output. ¢ No replacement diesel (reserve) units required. Intertie (incremental state cost): ¢ $65.1 million capital cost less $17.4 million federal grants = $47.7 million. e Assumes Tyee energy availability equal to project capability of 134,400 MWh per year plus capability of Petersburg municipal hydro system (10,000 MWh per year), less projected energy requirements for Petersburg and Wrangell. e Zero incremental cost of Tyee output. e No replacement diesel (reserve) units required. Mahoney Lake: ¢ $28.8 million (per 1998 Beck analysis) and $17.5 million (per KEC/HDR). e Capacity credit since connection is at Beaver Falls. e No replacement diesel (reserve) units required. Small Hydro: e Assumes Whitman Lake (added in 2002). e No replacement diesel (reserve) units required. Real Discount Rate: 3.0 percent A-8 ASSUMPTIONS - Low Load Forecast (continued): Rate Impact Analysis e Capital financed at 5.5% over 30 years. e Mahoney Lake energy at proposed KEC rate of 6.5 cents/kWh; project would be subordinate to Swan Lake. Existing KPU hydro and non-power supply costs escalate with inflation (3% per year). A-9 Attachment B Rate Impact Analysis of Power Supply Resource Options At Ketchikan, Alaska Under medium load forecast conditions: The Intertie would increase Ketchikan Public Utilities (KPU) rates relative to other new power supply alternatives, including diesel generation, Mahoney Lake, and Small Hydro (Whitman Lake and Lake Connell). [Rate impacts of the Intertie were adjusted to reflect reductions in the Four Dam Pool wholesale power rate due to increased sales from Tyee Lake (affects both purchases from Tyee Lake and Swan Lake).] The Small Hydro alternative would result in the lowest cost to KPU ratepayers. Under high load forecast conditions: The Intertie would reduce KPU rates relative to diesel generation but increase rates relative to the Mahoney Lake and Small Hydro alternatives. Mahoney Lake would result in the lowest cost to KPU ratepayers. Under low load forecast conditions: The Intertie and Mahoney Lake alternatives would all increase rates relative to the All Diesel alternative. The Small Hydro and All Diesel alternatives would result in about the same rates for KPU customers over the long term. These findings are based on the following key assumptions: KPU would pay 6.8 cents per kWh (the Four Dam Pool wholesale power rate), plus full contributions to an Intertie R&R Fund , for power delivered over the Intertie. O&M associated with the Intertie would be paid for through the Four Dam Pool wholesale power rate as an additional O&M budget item. Mahoney Lake power to meet requirements beyond those met by Swan Lake and existing KPU hydro would be available to KPU for 6.5 cents per kWh. Small hydro would be built with tax-exempt financing. Rate projections (in nominal, or current year, prices) are shown in Tables B-1 through B-3. These table are based on medium, high, and low load forecasts, respectively. B-1 Attachment C Sensitivity Analysis of Power Supply Resource Options At Ketchikan, Alaska 1. How would the results of the economic/resource and rate impact analyses change with higher diesel fuel costs? A higher fuel price assumption benefits cases that do not rely on significant amounts of diesel generation, such as the Intertie and Mahoney Lake resource scenarios. The analyses summarized in Attachments A and B are based on an initial diesel fuel price of 63 cents per gallon (the average fuel price paid by KPU over the past 3 years). Results of an analysis based on a fuel price of 85 cents per gallon are shown in Table C-1. Under medium load forecast conditions, with the high fuel price assumption, the Intertie, Mahoney Lake, and Mahoney Lake/Intertie alternatives are the lowest cost resource plans. Under high load forecast conditions, with the high fuel price assumption, the Mahoney Lake/Intertie case is clearly the least cost alternative, followed by the Intertie and Mahoney Lake alternatives. Under low load forecast conditions, with the high fuel price assumption, Small Hydro/Diesel remains the least cost resource plan, followed by the Mahoney Lake and Intertie cases. With the high fuel price assumption, results of the rate impact analysis would show an increased benefit (in terms of reduced KPU rates relative to the All Diesel scenario) for all alternatives examined. However, the relative differences in rate impacts among the alternatives (Intertie, Mahoney Lake, and Small Hydro) would be unchanged; i.e., each case would be reduced by approximately the same amount (0.3 to 0.5 cents per kWh under medium load forecast conditions). 2. What is the impact of the sale of Tyee power over the Intertie on the Four Dam Pool wholesale power rate? This analysis assumed that Tyee sales to KPU would be based on the existing debt service component (4 cents per kWh) of the Four Dam Pool wholesale power rate’, > The Four Dam Pool Power Sales Agreement provides for a reduced debt service component (3 cents per kWh) on all sales above the contracted forecast amounts. For this analysis, however, the existing debt service component of 4 cents per kWh was used to allow the State to more fully recover debt service costs associated with the Intertie. C-1 3. With increased sales of Tyee power, however, the O&M component of the Four Dam Pool wholesale power rate would change. On the one hand, the overall O&M amount to be paid would increase with the added O&M cost for the Intertie*. On the other hand, this increase would be more than offset by the effect of increased sales of Tyee power over the Intertie. Total O&M costs (including those for the Intertie) would be divided by a greater number of kilowatt-hours than would be the case without the Intertie. This would result in a net decrease in the overall O&M rate for Four Dam Pool power as shown in Table C-2. This shows the change in the projected Four Dam Pool wholesale power rates under medium and high load forecast conditions. The first 10 years of Intertie operation would result in reductions of the Four Dam Pool rate ranging from 0.2 to 0.4 cents per kWh. These reductions were incorporated into the rate impact analysis shown in Tables B-1 through B-3. What are the projected revenues to the State of Alaska for the Intertie and Mahoney Lake/Intertie cases? Gross revenues represent a payment of 4 cents per kWh on all Tyee Lake sales delivered over the Intertie (based on the assumption that Tyee sales to KPU would include the full debt service component of the current Four Dam Pool wholesale power rate). If the State builds the Intertie, net revenues would equal gross revenues minus debt service (assuming levelized $4.13 million in annual debt service costs). Results are shown for the Intertie and Mahoney Lake/Intertie cases in Tables C-3 and C-4, respectively. For the Intertie scenario, net revenues to the state would be negative for the 25 years during which the state is paying debt service on the Intertie. Similarly, for the Mahoney Lake/Intertie scenario, net revenues to the state would be negative for the 25 year repayment period. However, since less Tyee energy would be required under this scenario due to the availability of output from the Mahoney Lake project, the net loss to the state during the first 25 years would be higher than if only the Intertie were built. Under low load forecast conditions, all of KPU’s energy requirements during the forecast period would be met by existing hydro, Swan Lake, and the Mahoney Lake project. Since no Tyee energy would be utilized, the Intertie would not be needed. What if the Metlakatla Interconnection were constructed? Estimates contained in the 1998 update to KPU’s Power Supply Planning Study (prepared by R.W. Beck) indicate that about 10,200 MWh of hydroelectric energy and as much as 37,600 MWh of diesel energy could be made available annually via interconnection with Metlakatla Power & Light (MP&L). MP&L’s diesel units could * The analysis assumes that the incremental cost of Tyee Lake output is zero. C-2 also provide reserve capacity to KPU. An additional 3 MW of capacity (14,800 MWh per year) could be installed at the Chester Lake hydro project?. The Beck analysis found that the Metlakatla interconnection was similar to that of the Small Hydro alternative, assuming that KPU would pay costs associated with the interconnection with MP&L and the upgrade to the Chester Lake powerhouse plus 2 cents per kWh for power purchased from MP&L’s existing hydro resources. The MP&L interconnection would therefore be one of the lowest cost resource alternatives under all three load growth scenarios. > Other hydroelectric projects, such as Tamgas Lake and Triangle Lake, would increase the amount of energy available from MP&L. These projects were not considered in the 1998 update to the Power Supply Planning Study. C-3 Attachment D Sources of Information 1. Load Forecasts: KPU: Base Adjustments (see “Assumptions”) Other Four Dam Pool participants: 2. Diesel Fuel Cost ($.63/gallon): 3. Generation Resource Alternatives: Diesel unit costs and operating assumptions Small hydro unit costs and operating assumptions Mahoney Lake capital cost ($28.8 million), O&M, and operating assumptions Alternative Mahoney Lake project capital cost ($17.5 million) Electric Load Growth Study (prepared for KPU by ISER, June 1998). Per discussions and correspondence with KPU staff (R. Trimble). Electric Load Forecast for Ketchikan, Metlakatla, Petersburg, and Wrangell, Alaska: 1990-2010 (prepared for AEA by ISER, June 1990). KPU 1998 Avoided Cost Documentation (prepared by R.W. Beck, November 1998); represents average of Bailey fuel purchases (1997-1999) per KPU records. 1998 Update to the Power Supply Planning Study (prepared for KPU by R.W. Beck, February 1998). 1998 Update to the Power Supply Planning Study (prepared for KPU by R.W. Beck, February 1998). 1998 Update to the Power Supply Planning Study (prepared for KPU by R.W. Beck, February 1998). Per KEC (attachment to memo from John Magyar to the Ketchikan City Council, March 4, 1998). D-1 4. Intertie Cost and Operating Data: Total cost ($77.2 million) Net cost ($73.2 million) “Sunk” costs ($8.1 million) Federal funds ($17.4 million) Four Dam Pool wholesale power rate (before Tyee sales to KPU) Tyee capability (134,400 MWh) Petersburg municipal hydro capability (10,000 MWh) Projected Tyee sales to KPU Memo from Pat Clancy to AIDEA, March 11, 1999. Draft SE Intertie Review, March 23, 1999. Memo from Rich Trimble (KPU) to AIDEA, September 18, 1998. Memo from John Magyar (KPU) to Ketchikan City Council, September 25, 1998. Historical data per KPU; projected data based on the methodology outlined in the Four Dam Pool Power Sales Agreement. 1998 Update to the Power Supply Planning Study (prepared for KPU by R.W. Beck, February 1998). 1998 Update to the Power Supply Planning Study (prepared for KPU by R.W. Beck, February 1998). Developed using R.W. Beck resource model. D-2 Table A-1 Swan/Tyee Intertie Analysis Summary of Results (Incremental Analysis) 1 Present Value of Costs ($ millions) Medium High Low Forecast Forecast Forecast Resource: All Diesel 84.7 207.3 17.6 Intertie (full cost) 91.1 176.8 67.8 Intertie (incremental cost) 84.6 170.3 613 Intertie (incremental state cost) 69.1 154.8 45.8 Mahoney Lake ($17.5 million)” 40.3 116.9 29.1 Mahoney Lake ($28.8 million) 50.9 129.2 39.7 Mahoney Lake ($17.5 million) and Intertie (state)> 58.7 119.4 NA Small Hydro 41.8 170.4 9.7 Index (All Diesel = 100) Medium High Low Forecast Forecast Forecast Resource: All Diesel 100 100 100 Intertie (full cost) 108 85 385 Intertie (incremental cost) 100 82 348 Intertie (incremental state cost) 82 75 260 Mahoney Lake ($17.5 million)” 48 56 166 Mahoney Lake ($28.8 million) 60 62 225 Mahoney Lake ($17.5 million) and Intertie (state)> 69 58 NA Small Hydro 49 82 55 Notes: 1 Costs evaluated are for years 2001 through 2027. These costs exclude those associated with Swan Lake, existing diesel units, and existing KPU hydro. 2 For high forecast ONLY, includes small hydro (Whitman and Connell Lakes) instead of new diesel units when new resources are required. 3 Under medium load forecast, construction of the Intertie is delayed until 2011. Under the high forecast, both Mahoney lake and the Intertie are constructed in 2001. Under the low forecast, the Intertie is not needed. Figure A-1 Mahoney Lake vs. Intertie Low Medium © Mahoney Lake ($17.5 Million) 4 Intertie ($47.7 Million) Figure A-2 Small Hydro vs. Intertie 180 160 ) —_ rs oO 120 60 Present Value ($ Millions 40 - 20 - O Small Hydro 3 Intertie ($47.7 Million) Medium Figure A-3 KPU Load Forecasts r LIOT r SIOZ f £107 r [107 r £861 r [861 r 6L6I1 300 100 + 50 +4 0 T S nw “4 250 +4 200 + YM» JO SUOTTTTAL —— Revised - = = Original Table B-1 Rate Impact Analysis Medium Load Forecast Average Power Supply Retail Rate Cost Under Under Do-Nothing Do-Nothing Alternative Alternative Estimated Rate Impacts (cents/kWh) 2 Year (cents/kWh) : (cents/kWh) Intertie * Mahoney 4 Small Hydro 2 1998 9.2 4.7 - - - 1999 9.4 4.8 - - - 2000 9.6 4.8 - - - 2001 9.8 4.9 0.1 0.1 - 2002 10.0 5.0 0.1 0.1 (0.2) 2003 10.2 5.0 0.1 0.1 (0.2) 2004 10.4 D1 0.1 0.1 (0.2) 2005 11.6 6.1 0.1 (0.9) (1.2) 2006 11.8 6.2 0.1 (0.9) (1.2) 2007 12.0 6.2 0.1 (0.9) (1.2) 2008 12.3 6.3 0.1 (0.9) (1.2) 2009 12.5 6.3 0.2 (0.9) (1.2) 2010 12.7 6.4 0.2 (0.9) (1.2) 2011 13.0 6.4 0.2 (0.9) (1.2) 2012 13.2 6.5 0.2 (0.9) (1.2) 2017 14.6 6.8 0.3 (1.0) (1.2) 2022 15.9 6.8 (0.0) (1.2) (1.2) 2027 17.4 6.8 (0.0) (1.2) (1.2) Levelized 12.8 6.1 0.1 (0.8) (1.1) Notes: 1 Represents All-Diesel case; capital financed at 5.5% over 20 years. Assumes 3 percent general inflation rate. 2 Relative to All-Diesel case. 3 At Four Dam Pool rate plus renewals and replacements. 4 KEC proposal (6.5 cents/kWh), subordinate to Swan Lake. 5 Assumes capital cost financed at 5.5% over 30 years. Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2017 2022 2027 Levelized Notes: Table B-2 Rate Impact Analysis High Load Forecast Average — Power Supply Retail Rate Under Cost Under Do-Nothing Do-Nothing Alternative Alternative Estimated Rate Impacts (cents/kWh) 2 (cents/kWh) ' (cents/kWh) Intertie ° Mahoney * Small Hydro 5 9.2 4.7 - - - 94 4.8 - - - 9.6 4.9 - - - 9.8 4.9 (0.2) (0.0) - 10.7 5.7 (0.4) (1.1) (1.0) 10.9 5.7 (0.4) (4) (0.9) 11.1 5.8 (0.2) (1.1) (0.9) 11.3 5.8 (0.2) (1.1) (1.0) 11.8 6.1 (0.3) (1.4) (1.3) 12.0 6.2 (0.3) (1.4) (0.6) 12.2 6.2 (0.2) (1.4) (0.6) 12.4 6.2 (0.2) (1.4) (0.6) 12.6 6.3 (0.2) (1.3) (0.6) 12.8 6.3 (0.1) (1.3) (0.6) 13.1 6.3 (0.1) (1.3) (0.6) 14.5 6.7 (0.0) (1.5) (0.5) 15.8 6.7 (0.3) (1.7) (0.5) 173 6.7 (0.3) (1:7) (0.5) 13.0 6.1 (0.2) (1.4) (0.6) Represents All-Diesel case; capital financed at 5.5% over 20 years. Assumes 3 percent general inflation rate. Relative to All-Diesel case. At Four Dam Pool rate plus renewals and replacements. KEC proposal (6.5 cents/kWh), subordinate to Swan Lake, plus costs associated with small hydro. Assumes capital cost financed at 5.5% over 30 years. Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2017 2022 2027 Levelized Notes: nk WN Table B-3 Rate Impact Analysis Low Load Forecast Average — Power Supply Retail Rate Cost Under Under Do-Nothing Do-Nothing Alternative Alternative Estimated Rate Impacts (cents/kWh) (cents/kWh) ' _(cents/kWh) Intertie? Mahoney* Small Hydro > 9.2 47 - - - 9.3 47 - - - 9.5 4.8 - - - 9.7 4.9 0.0 0.0 - 10.0 4.9 0.0 0.0 0.3 10.2 5.0 0.0 0.0 0.3 10.4 5.1 0.1 0.0 0.3 10.6 5.1 0.1 0.0 0.2 10.9 5.2 0.1 0.0 0.2 11.1 a3 0.1 0.0 0.1 11.4 54 0.1 0.0 0.1 11.7 5.5 0.2 0.0 0.0 11.9 5.6 0.2 0.0 0.0 12.2 5.7 0.2 0.0 (0.0) 12.5 5.8 0.2 0.0 (0.1) 14.3 6.5 0.4 0.0 (0.2) 15.6 6.6 0.3 (0.1) (0.3) 17.1 6.6 0.3 (0.1) (0.3) 12:3 5.7 0.2 (0.0) (0.0) Represents All-Diesel case; capital financed at 5.5% over 20 years. Assumes 3 percent general inflation rate. Relative to All-Diesel case. At Four Dam Pool rate plus renewals and replacements. KEC proposal (6.5 cents/kWh), subordinate to Swan Lake, plus costs associated Assumes capital cost financed at 5.5% over 30 years. Table C-1 Results of Fuel Price Sensitivity Analysis Present Value of Change in PV Revised Cost Assuming Due to Incremental Revised Load Base Fuel Prices Index High Fuel Costs Present Value Index Forecast Resource Scenario ($millions) (All-Diesel=100) ($millions) ($millions) (All-Diesel=100) Medium: Base (All-Diesel) 84.7 100 179.3 264.0 100 Intertie ' 69.1 82 12.2 81.3 31 Mahoney Lake ” 40.3 48 40.5 80.8 31 Small Hydro 2 418 49 95.8 137.6 52 Mahoney + Intertie 58.7 69 12.2 70.9 27 High: Base (All-Diesel) 207.3 100 463.2 670.5 100 Intertie | 154.8 75 189.0 343.8 51 Mahoney Lake 4 116.9 56 233.4 350.3 52 Small Hydro * 170.4 82 373.9 544.3 81 Mahoney + Intertie 119.4 58 89.4 208.8 31 Low: Base (All-Diesel) 17.6 100 53.9 71.5 100 Intertie | 45.8 260 5.4 51.2 72 Mahoney Lake ” 29.1 166 5.4 34.5 48 Small Hydro ° 9.7 55 6.1 15.8 22 Notes: 1 Incremental state cost. 2 $17.5 million capital cost. 3 Whitman and Connell Lake projects. 4 Mahoney Lake augmented by small hydro when needed. 5 Whitman Lake project. Due to Tyee Lake Sales Over Intertie Table C-2 Change in Four Dam Pool Rate Reduction in O&M Component of Wholesale Power Rate (cents/kWh) Medium Load Forecast High Load Forecast Due to Add: Due to Add: Increased Intertie Net Increased Intertie Net Tyee Sales' O&M — Change Tyee Sales' O&M? — Change 1998 - - - - - - 1999 - - - - - - 2000 - - - - - - 2001 -0.21 0.04 -0.17 -0.36 0.03 -0.32 2002 -0.24 0.04 -0.19 -0.38 0.03 -0.35 2003 -0.26 0.05 -0.21 -0.40 0.03 -0.37 2004 -0.27 0.05 -0.23 -0.43 0.03 -0.39 2005 -0.29 0.05 -0.25 -0.44 0.03 -0.40 2006 -0.31 0.05 -0.27 -0.44 0.03 -0.41 2007 -0.33 0.05 -0.28 -0.44 0.04 -0.41 2008 -0.36 0.05 -0.31 -0.44 0.04 -0.41 2009 -0.38 0.05 -0.33 -0.45 0.04 -0.41 2010 -0.40 0.05 -0.35 -0.45 0.04 -0.41 2011 -0.42 0.05 -0.37 -0.45 0.04 -0.41 2012 -0.45 0.05 -0.39 -0.45 0.04 -0.41 2013 -0.48 0.05 -0.42 -0.44 0.04 -0.40 2014 -0.50 0.06 -0.45 -0.44 0.04 -0.40 2015 -0.53 0.06 -0.48 -0.43 0.04 -0.39 2016 -0.56 0.06 -0.51 -0.43 0.04 -0.39 2017 -0.60 0.06 -0.54 -0.42 0.04 -0.38 2022 -0.63 0.07 -0.56 -0.42 0.05 -0.37 2027 -0.63 0.08 -0.55 -0.42 0.06 -0.36 Notes: 1 Four Dam Pool O&M cost assumed to be constant in real terms. Reduction in unit cost results from dividing by larger number of kWh. 2 O&M for the Intertie is estimated to be $126,000 ($1998). Cost is spread over all Four Dam Pool sales, including sales of Tyee power to KPU. Table C-3 Revenues to the State of Alaska From Tyee Sales to KPU (via the Intertie) (Intertie Scenario) : Thousands of Dollars Gross Revenues 2 Net Revenues * Low Medium High Low Medium High Forecast Forecast Forecast Forecast Forecast Forecast 1998 - - - - - - 1999 - - - - - - 2000 - - - - - - 2001 179 1,029 2,578 (3,951) (3,101) (1,552) 2002 190 1,118 2,770 (3,940) (3,012) (1,360) 2003 207 1,180 2,952 (3,923) (2,950) (1,178) 2004 245 1,244 3,125 (3,885) (2,886) (1,005) 2005 282 1,304 3,298 (3,848) (2,826) (832) 2006 324 1,369 3,419 (3,806) (2,761) (711) 2007 374 1,431 3,376 (3,756) (2,699) (754) 2008 405 1,498 3,330 (3,725) (2,632) (800) 2009 433 1,562 3,285 (3,697) (2,568) (845) 2010 464 1,631 3,243 (3,666) (2,499) (887) 2011 496 1,697 3,204 (3,634) (2,433) (926) 2012 527 1,763 3,165 (3,603) (2,367) (965) 2013 556 1,839 3,124 (3,574) (2,291) (1,006) 2014 588 1,920 3,080 (3,542) (2,210) (1,050) 2015 620 2,001 3,035 (3,510) (2,129) (1,095) 2016 653 2,084 2,989 (3,477) (2,046) (1,141) 2017 682 2,168 2,942 (3,448) (1,962) (1,188) 2022 715 2,252 2,894 (3,415) (1,878) (1,236) 2027 715 2,252 2,894 715 2,252 2,894 1998 Present Value: (37,472) (25,132) (10,047) Notes: 1 Assumes Intertie constructed in 2001. 2 Assumes KPU payment to the state of 4 cents per kWh on all purchases from the Tyee Lake project. 3 Gross revenues less levelized debt service cost to the state (assumed to be $4.13 million per year). Represents unrecovered debt service payments. Table C-4 Revenues to the State of Alaska From Tyee Sales to KPU (via the Intertie) (Mahoney Lake/Intertie Scenario) Thousands of Dollars Gross Revenues ___NetRevenues” Medium High Medium High Forecast’ Forecast * Forecast ° Forecast * 1998 - - - - 1999 - - - - 2000 - - - - 2001 - 925 - (3,205) 2002 - 1,117 - (3,013) 2003 - 1,299 - (2,831) 2004 - 1,472 - (2,658) 2005 - 1,645 - (2,485) 2006 - 1,822 - (2,308) 2007 - 2,004 - (2,126) 2008 - 2,191 - (1,939) 2009 - 2,082 - (1,748) 2010 - 2,579 - (1,551) 2011 44 2,781 (4,086) (1,349) 2012 110 2,988 (4,020) (1,142) 2013 186 3,124 (3,944) (1,006) 2014 267 3,080 (3,863) (1,050) 2015 348 3,035 (3,782) (1,095) 2016 431 2,989 (3,699) (1,141) 2017 515 2,942 (3,615) (1,188) 2022 599 2,894 (3,531) (1,236) 2027 599 2,894 (36,571) ° 2,894 1998 Present Value: (20,785) (19,191) Notes: 1 Assumes KPU payment to the state of 4 cents per kWh on all purchases from the Tyee Lake project. . 2 Gross revenues less levelized debt service cost to the state (assumed to be $4.13 million per year). Represents unrecovered debt service payments. Assumes construction of Mahoney Lake in 2001 and the Intertie in 2011. Assumes both Mahoney Lake and the Intertie constructed in 2001. 5 Assumes balloon payment made in 2027 for remaining debt service costs (under medium load forecast only). pw EXHIBIT 2 f Financial Counsel to Governments, Non-Profits & Public Private Ventures GARDINER, j a att +PIERCE, oa ay March 31, 1999 Keith Laufer Alaska Industrial Development and Export Authority 480 West Tudor Anchorage, Alaska 99503 Dear Keith: Pursuant to your request, we have analyzed the various financing issues surrounding a proposal being advanced by Ketchikan Public Utilities (KPU) for the Southeast Intertie (the “Intertie”). KPU has asked the State to consider issuing revenue bonds to fund approximately $45 million of costs relating to construction of the Intertie. KPU’s proposal is to use 40% of the State’s Four Dam Pool income stream to provide a revenue stream with which to pay debt service on the bonds. The Southeast Intertie has been the subject of considerable study and discussion over the past decade. The Intertie would link the Tyee hydroelectric project (a part of the Four Dam Pool) to the Ketchikan area. The proposed funding package is as follows: Funding Available: State Grants Authorized/Received 11,200,000 Fed. Grants Authorized/Received 9,900,000 Timber Sale Credit 4,000,000 25,100,000 Additional Funding Pro Additional Proposed Federal Grants 7,500,000 Proposed State Bond Proceeds 44 000 52,100,000 Total Estimated Intertie Cost (As of 9/98 in 1997 dollars) $77,200,000 In order to have approximately $44,600,000 in bond proceeds available for Intertie construction costs, we estimate that approximately $51,300,000 in revenue bonds would need to be issued. The increased bond size is needed to provide proceeds for bond issuance costs and to fund a debt service reserve fund. Although the amounts could vary, for this purpose we have assumed that issuance costs will amount to approximately 3% of the principal of the bonds and that a debt service reserve fund equal to approximately 10% of the bond principal would be required. Since, under KPU’s proposal, completion of construction is not required to produce the revenue stream required for payment of the bonds, we have assumed that no provision for capitalized interest would be required. 115 NW First Avenue, Suite 401 Portland. Oregon 97209 Phone: 503.221.1126 Fax: 593.221.1560 SE Intertie Financing Page 2 As you know we believe the State should ordinarily not issue bonds unless those bonds are “investment grade.” If the Intertie bonds could be structured to be investment grade, we assume the interest rates on the bonds would be approximately 7%. These rates assume that the project would not qualify for tax exempt financing. We have also assumed the bonds would be amortized over a 25-year term. Based upon these assumptions, we estimate that the annual debt service on the bonds would be approximately $4.38 million. After taking into account the projected earnings on the debt service reserve fund, we estimate the annual net debt service for the bonds would be approximately $4.13 million. Investment grade revenue bond financing requires a predictable stream of revenue to repay the bonds over time. However, there is currently no revenue stream that has been earmarked to pay debt service on such bonds and the Intertie will not generate significant new revenue. Therefore the first task toward issuing bonds would be to identify a viable revenue stream for debt service payments. The State receives “debt service” payments from the Four Dam Pool participants. Subject to annual appropriation, these State payments are currently allocated: 40% to the Power Cost Equalization and Rural Electric Capitalization Fund, 40% to the Southeast Energy Fund and 20% to the Power Project Fund. KPU has proposed that the 40% of these funds currently being allocated to the Southeast Energy Fund be utilized to pay for the debt service on the proposed bonds. Because the State’s Four Dam Pool revenue stream is subject to annual appropriation, that revenue stream would not be sufficiently predictable and stable for the issuance of bonds. Presumably statutory changes could be made to remedy this deficiency. The total State “debt service payment” (before self help) for fiscal year 1999 was $10.8 million. A diversion of 40% of the current “debt service” payment would result in $4,320,000 per year potentially available for repayment of the proposed bonds. This would provide a baseline payment source for the bonds of 1.05 times the projected bond payments. While the State’s revenue stream is projected to grow over time and potentially increase debt service coverage, this level of base line coverage would probably be insufficient to support investment grade bonds. Additionally, the State’s debt service payments are subject to significant fluctuation based on Four Dam Pool energy production and sales and the payments are subject to interruption under certain conditions described in the Four Dam Pool power sales agreement (commonly referred to as “self help”). Each of these conditions make it more unlikely that the coverage provided by a pledge of 40% of the State’s payment would be sufficient to structure a viable investment grade bond issue. These two difficulties could be remedied by making structural changes to ensure State payments sufficient to pay debt service regardless of energy production and revenue interruptions created by the exercise of self-help. One option for addressing the revenue fluctuation and coverage problems would be to pledge the State’s entire Four Dam Pool revenue stream toward the bonds. Once the bond payment was made the remainder of the State revenues could be released for other purposes. This approach would create the potential of reducing the amount of Four Dam Pool revenues available for the other allocated uses. Using the State’s fiscal year 1999 revenues (before self-help) of $10.8 million would result in bond debt service coverage in excess of 2.6 times. This level of coverage, in normal circumstances and with normal reserves, should lead to an investment grade bond issue. However, the potential of self-help creates a second hurdle. SE Intertie Financing Page 3 Self-help is a unique ability of the Four Dam Pool purchasing utilities to interrupt the State debt service payments to obtain funds for certain State obligations for costs associated with the projects. Over the last several years self-help has been utilized to meet the State’s obligations for major repair of the project. In fiscal year 1999 alone, the State’s $10.8 million debt service payment was reduced by $5.5 million for self-help resulting in a net payment to the State of only $5.3 million. To avoid the possibility of self-help interrupting bond payments, it might be possible to amend the Four Dam Pool power sales agreement to limit the utilities’ ability to invoke self-help. In the last several years, however, self-help funds have been the only source of funds available to make major repairs to the Four Dam Pool projects. Restrictions on the availability of self-help funds could impede AEA’s ability to fulfill its obligations and the State would have to meet those obligations using other unidentified funds. Both of the structural changes described above would need to be designed to contractually guarantee sufficient revenues to the State so that debt service payments could be made. Assuming such changes were made, the State could contractually commit those payments to debt service on the bonds. Another approach to the financing would be to divert only 40% of the revenue stream toward the bonds without modifying the power sales agreement or pledging the entire revenue stream. In this case, any deficiency in the revenues available to pay debt service would need to be guaranteed by a sufficiently creditworthy entity. Ketchikan Public Utilities might be considered the most appropriate entity but may lack the financial strength to make a guarantee on $51.3 million meaningful. Another option might be to back the debt service payments by a “general obligation” pledge of all of the Four Dam Pool participants. The value of any guarantee is dependent on the guarantor’s ability to make good on the guarantee in the event that the revenue stream failed to materialize. In summary, a reliable revenue stream for repayment of the financing needs to be developed. Forty percent of the current debt service paid by the Four Dam Pool is not sufficient to structure an investment grade bond issue. While it might be possible to modify the existing structure to create a sufficient revenue stream by pledging all the debt service payment and limiting self-help provisions, this solution seems unlikely and presents other problems. In the absence of changes to the existing structure the bond debt service would need to be guaranteed by a creditworthy entity. Finally, before issuing bonds, a plan would need to be developed to securely fund the operating, maintenance, and renewal and replacement costs for the Intertie, and to cover any other known Intertie risks. Please feel free to contact me if you have any questions regarding this analysis. , Gardiner & Pierce, LLC Patrick H. Clancy DRAFT CONFIDENTIAL Revised Southeast Intertie Plan April 22, 1999 Revised Intertie Proposal KPU’s existing $77.2 million Intertie proposal abandoned e Analysis shows that this plan is not economic KEC (APT/Cape Fox) immediately develops the Mahoney Lake project e KPU enters into long term power sales agreement with KPU e Mahoney can be on line within 18 months A High Voltage Direct Current (HVDC) Intertie linking the Ketchikan area with the Tyee (Wrangell/Petersburg) area is developed e Intertie could be completed in 4-5 years and then be available to serve KPU’s excess energy needs for the long term e KPU would seek a guaranteed maximum price contract for construction of the Intertie and appropriate guarantees covering the technology and performance e HVDC intertie development is less expensive than development conventional AC intertie technology; projected cost for HVDC Intertie is as low as $40 million e HVDC technology is considered to be more environmentally benign e HVDC would follow a different route with more undersea crossings thus minimizing environmental impacts Benefits of Plan HVDC technology minimizes environmental impacts e Less visual impact e Narrower right-of way e Proposed route places greater portion of line off-shore HVDC technology reduces operational problems associated with connecting isolated generating sources May be supported by Clinton Administration and environmental groups Ketchikan gets both the Mahoney Lake project and the Intertie Because state bonds are not required for development, the state could consider reducing the state portion of the Four Dam Pool power rate on Tyee power sales over the Intertie HVDC technology lowers costs for the Intertie and if successful could lower projected costs for other segments of the proposed Southeast Interconnect System plan Development of both Mahoney and the Intertie increases power reliability to the interconnected communities and provides greater flexibility in the event of low water conditions in the Ketchikan area. DRAFT CONFIDENTIAL e Risks associated with Plan e HVDC technology is not commercially proven e To date there are very few completed projects utilizing the technology e Risk can be mitigated by obtaining appropriate technology and other guarantees from developer and technology owner e HVDC route includes increased use of undersea crossings e Undersea crossings generally have greater risk e Risk can be mitigated with appropriate warranties from the cable manufacturer e Funding Proposal for HVDC Intertie e The following summarizes the HVDC Intertie funding proposal: State Grants Received but not yet committed $ 3,100,000 Federal Grants Authorized/Received 9,900,000 FY 99 proposed Southeast Energy fund grant 4,400,000 Proposed additional federal funding 20,000,000 Additional state grant-DCRA authorized loan released 8,000,000 Total available funds (excluding interest) $45,400,000 e The following highlights particular aspects of the funding plan: e $20.0 million or more in additional federal funding would be sought. e Anenergy bill recently introduced by the Clinton Administration includes $20 million in authorization for the Intertie (no appropriation yet introduced) e The Clinton Administration appears interested in developing the more environmentally friendly HVDC technology e The existing $20 million dollars appropriated to DCRA to be used for an Intertie loan would be re-appropriated as follows: e $8 million (plus future interest earnings) would be appropriated to the Southeast Energy fund to be used for grants for the Intertie e Grant funds would only be released upon AIDEA’s approval of a finance plan showing the Intertie can be completed within available funding sources e The remaining $12 million would be appropriated to the PCE fund e The 40% of Four Dam Pool revenues currently allocated to the Southeast Energy Fund would continue to be devoted to the Intertie e However, upon approval by AIDEA of a finance plan showing the 40% is not needed for completion of the Intertie, the 40% share will automatically be reallocated to the PCE fund Revised Southeast Intertie Plan April 22, 1999 Page 2 DRAFT CONFIDENTIAL Interested parties to be contacted e Jack Shay, Ketchikan Borough Mayor Bob Weinstein, Ketchikan City Mayor Pete Eckman, Legislative aid to Rep. Bill Williams Senator Robin Taylor Dave Carlson, Chair of the Four Dam Pool divestiture committee and former Petersburg Mayor e Dennis Lewis, Chair of the Four Dam Pool Project Management Committee e Other Four Dam Pool representatives e Robert Wilkinson, General manager Copper Valley Electric Association e Ed Kozack and Walter Sapp, Kodiak Electric Association Revised Southeast Intertie Plan April 22, 1999 Page 3